Financial Management

A financial strategy aims to achieve financial goals by managing financial resources effectively.
Financial strategies include:
Investment Choosing where to invest money to ensure maximum returns and business
Decision: growth.
Financing Determining how to raise funds for business operations.
Decision:
Dividend Deciding how much profit should be distributed to shareholders and how
Decision: much should be reinvested in the business.
Risk Identifying and handling financial risks such as foreign exchange risk, interest
Management: rate risk, etc.

Financial strategies are implemented through:

Plans and Detailed financial plans for achieving objectives.
statements:
Budgets and Estimating future financial needs and performance, including cash flow
forecasts: forecasting.
Internal Measures to ensure financial resources are managed properly and risks are
controls: minimized.

Maximisation of Shareholder Wealth

Maximising shareholder wealth is a key objective for businesses, helping managers make
better financial and strategic decisions.
Shareholder wealth is determined by two factors:
Dividends Profits distributed to shareholders
Share price Increase in the company's share value
growth
Together, these factors form Total Shareholder Return (TSR), which is a key measure of a
company's financial success.
Capital Yield + Dividend Yield
TSR (Change in Share Price / Opening Share Price) + (Dividend Per Share / Opening Share Price)
(Change in Share Price + Dividend Per Share ) / Opening Share Price

Justification
Higher Returns When a company provides higher returns to investors, it gains trust in the
Make market. This makes it easier to raise funds through equity or debt financing
Fundraising for expansion.
Easier
Example:
Reliance Industries, led by Mukesh Ambani, has consistently delivered high
shareholder returns. Because of its strong financial position, it has been able
to attract global investors.
Providing Companies that focus on customer satisfaction achieve sustained profits,
Value to leading to higher stock prices and dividends for shareholders.
Customers
Example:
TCS provides quality IT services globally. Because it consistently meets
customer needs, it earns high profits, leading to increased stock prices and
regular dividend payouts for investors.
Companies If a company fails to provide adequate returns, it may become a target for
with Low acquisition by a stronger competitor.
Returns Risk
Hostile
Takeovers
Companies If a company fails to provide adequate returns, it may become a target for
with Low acquisition by a stronger competitor.
Returns Risk
Hostile Example:
Takeovers Mindtree was an underperforming IT company, making it a target for a hostile
takeover by Larsen & Toubro (L&T) in 2019.
Directors Have Company directors are legally responsible for ensuring profits and value
a Duty to appreciation for shareholders.
Maximize
Wealth for
Shareholders

Criticism
Ignores Market Maximizing shareholder wealth can lead to monopoly power, reducing market
Imperfections competition and increasing prices for consumers.
Example:
When Reliance Jio entered the market, it offered free services, leading to the
exit of several competitors like Aircel and TATA Docomo. This created a near-
monopoly, and once competition reduced, Jio started increasing prices.
Ignores Social Companies focused only on profit may neglect essential social responsibilities,
Needs like providing affordable healthcare.
Example:
Sun Pharma has been criticized for increasing medicine prices, making
essential drugs expensive for the public, while focusing on wealth
maximization.
Neglects Other Companies may exploit employees or cut costs at the expense of customer
Stakeholders satisfaction to increase profits.
Example:
Companies like Ola and Zomato have been criticized for harsh working
conditions for drivers and delivery partners, including low payouts and long
working hours, despite these firms increasing profits.
Not All Some shareholders are not focused on maximizing profits but rather on
Shareholders preserving legacy or social impact.
Prioritize
Maximum Example:
Returns Patanjali, led by Baba Ramdev, focuses on promoting Ayurveda and swadeshi
(self-reliance) rather than maximizing shareholder returns.

Relationship of Financial Management with Financial Accounting & Management Accounting

Financial Accounting
Financial accounting primarily deals with recording, summarizing, and reporting a company’s
financial transactions.
Example:
A company decides to lease equipment instead of purchasing it. If the lease term is longer
than 12 months, the company must recognize it as a liability, increasing its gearing (debt-to-
equity ratio). A higher gearing ratio might make it harder to secure additional loans.

Management Accounting
Management accounting focuses on internal reports that help in decision-making, planning,
and controlling operations.
Example:
A company forecasts its revenues and expenses for the upcoming year. If the budget shows a
potential cash deficit, management may need to arrange for additional financing (e.g., a bank
loan) or reduce expenses.
A company forecasts its revenues and expenses for the upcoming year. If the budget shows a
potential cash deficit, management may need to arrange for additional financing (e.g., a bank
loan) or reduce expenses.

Strategy
A strategy is an action plan to achieve an objective, varying in duration (long / medium / short
term). Strategies can be planned for pursuing two types of objectives:

Corporate Objectives
Corporate objectives pertain to the entire organization and often encompass a range of goals
such as:
Profit targets
Market share goals
Share price growth
Addressing local and environmental concerns
Maintaining a contented workforce

These objectives can be categorized as follows:

Profit Goals Directly enhance profits, such as cost reduction measures.
Surrogate Indirectly contribute to increased profits, like maintaining a contented
Profit workforce.
Goals
Constraints on Objectives that limit profits, such as ensuring operations do not harm the
Profit environment.
Dysfunctional Objectives that lack long-term benefits, for instance, pursuing market
Goals leadership
at any cost
A company may pursue either maximizing or satisficing these objectives:
Maximizing Aims for the best possible outcome in achieving objectives.
Satisficing Seeks an adequate outcome that meets the objectives, without necessarily
optimizing for the best possible result

Financial Objectives
Financial objectives encompass targets for various metrics, including:
Earnings per share (EPS)
Dividend per share (DPS)
Gearing level (debt-to-equity ratio)
Operating profitability (EBIT)

Total Shareholder Return

E.g. 1

Soln:
Opening Share Price 2.50 $
Closing Share Price 2.82 $
 $
Capital Gain i.e. growth in share price 0.32
Dividend 0.28
TSR 0.60

TSR 24%

E.g. 2

Soln:
(a) FALSE
Actual Performance
Sales in Previous Year 200
Sales in Current Year 400
% increase in Sales 100%

Expected Performance
Sales in Previous Year 200
Sales in Current Year 520 assumed
% increase in Sales 160%

Since the growth in sales is less than the expectation, this would negatively impact the
shareholders' perspective towards the company.
Hence, the share price could fall due to this reason.

(b) TRUE
Depreciation is a systematic allocation of cost of an asset over its useful life.
So, change in accounting policy for charging depreciation is least likely to be cause a fall in the
share price.

(c) FALSE
(d) FALSE

Cum-Dividend and Ex-Dividend Share Prices

Cum-Dividend This is the share price before the dividend payment is deducted. Investors
who buy shares during this period are entitled to receive the upcoming
dividend.
Ex-Dividend This is the share price after the dividend payment has been deducted.
Investors who buy shares during this period are not entitled to the upcoming
dividend.
E.g. 1
A company declares a dividend of 2 $ per share.
The cum-dividend share price is 50 $ per share.
Once the dividend is paid to the shareholders holding the shares on the record date (i.e. cut-
off date), the share price drops by the amount of dividend.
Therefore, the ex-dividend share price would be 48 $ per share.

Note: TSR is always calculated on ex-dividend share price.

Cum-Rights and Ex-Rights Share Prices

A rights share is an additional share offered by a company to its existing shareholders, giving
them the opportunity to buy more shares at a discounted price compared to the market
price.
Cum-Rights This is the share price before the rights issue. Investors holding shares are
entitled to subscribe to additional shares at a discounted price during a rights
issue.
Ex-Rights This is the share price after the rights issue. The price usually adjusts
downward to reflect the dilution caused by the issuance of additional shares.

E.g. 1
A company announces a 1-for-4 rights issue, allowing shareholders to buy 1 share for every 4
shares they hold at $40, while the cum-rights price is $50.
Calculate ex-rights price.

Soln:
Shares No of Shares Weight Cost Weighted Cost
Original Shares 4 80% 50 40
Rights Shares 1 20% 40 8
Ex-rights Price 5 48

Cum-Bonus and Ex-Bonus Share Prices

A bonus share is a free share issued by a company to its existing shareholders in proportion to
their current shareholding. Bonus shares are distributed from the company’s accumulated
profits and do not involve any cash transaction from the shareholders.
Bonus Shares are also known as Scrip Dividend.

Cum-Bonus This is the share price before the bonus shares are issued. Investors holding
shares during this period are entitled to receive the bonus shares.
Ex-Bonus This is the share price after the bonus shares are issued. The price is adjusted
downward to reflect the increased number of shares.

E.g. 1
A company announces a 1-for-2 bonus issue, while the cum-bonus price is $90.
Calculate ex-bonus price.

Soln:
Shares No of Shares Weight Cost Weighted Cost
Original Shares 2 67% 90 60
Bonus Shares 1 33% - -
Ex-bonus Price 3 60

Earnings Per Share (EPS)

EPS = PAT / No of Shares
If the no of shares reduce, EPS will increase.
So, directors may try to artificially increase the EPS by
Share consolidation
Share buyback

Share consolidation
A share consolidation is when a company reduces the number of its shares by combining
multiple shares into a single share.
E.g. 1
No of shares outstanding 100,000
Nominal Value 2 $ per share
Net Profit 100,000 $
Current EPS 1.00 $

Company announces 1-for-5 share consolidation. It means that every 5 old shares of the co.
will be converted into 1 new share.
No of shares outstanding 20,000
Nominal Value 10 $ per share
Net Profit 100,000 $
Revised EPS 5.00 $

Share buyback
A share buyback is when a company repurchases its own shares from the market, reducing
the number of outstanding shares. This is typically done when the company believes its stock
is undervalued or to return excess cash to shareholders.
E.g. 1
No of shares outstanding 1,000,000
Nominal Value 10 $ per share
Net Profit 500,000 $
Current EPS 0.50 $

Company buys back 200,000 shares

No of shares outstanding 800,000

Nominal Value 10 $ per share
Net Profit 500,000 $
Revised EPS 0.63 $

Non-Profit Organisation (NPO)

Value For Money (VFM)
Value for Money (VFM) refers to maximizing the benefits generated while minimizing costs. It
is particularly important for NPOs that aim to serve societal interests rather than generate
profit.
The 3 Es framework—Economy, Efficiency, and Effectiveness—helps assess VFM in an
organization.
Economy – Economy is about obtaining resources at the lowest possible cost while
Minimizing maintaining the required quality. It ensures the organization spends wisely.
Input Costs
Example:
A charity providing school meals sources ingredients from a wholesale
supplier instead of a local supermarket, reducing food costs while maintaining
quality.
Performance Measure: Cost per meal served
Efficiency – Efficiency means achieving the best possible outcome with the given
Maximizing resources, minimizing waste and maximizing productivity.
Output/Input
Ratio Example:
A healthcare NGO uses a digital records system to streamline patient data,
allowing doctors to see more patients per day without increasing costs.
Performance Measure: Patients treated per doctor per day
Effectiveness – Effectiveness measures how well the organization's objectives are met using
Achieving the available resources.
Organizational
Goals Example:
A disaster relief organization successfully provides aid to 90% of affected
families within 24 hours, achieving its objective.
Performance Measure: Response time in hours per disaster event

Measuring Performance of NPOs:

Unlike profit-driven companies, which measure success through financial metrics like revenue
and profit, NPOs have multiple and sometimes conflicting objectives. Measuring their
performance is difficult because:
Success is not always linked to financial outcomes.
The impact of their work may take years to materialize.
Performance indicators can be subjective.

Ways to measure NPO Performance:

Expert Some performance assessments rely on the opinions of experts in the field.
Judgments Example:
An education NGO may have its teaching quality reviewed by academic
experts. performance against other similar organizations or past
Comparisons Comparing
to Similar performance can provide meaningful insights.
Organizations
or Historical Example:
Data A university assessing its graduation rate compared to national averages.

Stakeholders
Stakeholders are individuals or groups that have an interest in, are affected by, or can affect
the operations and decisions of a business.
They can be categorised as follows:
Category Explanation Examples
Internal These are stakeholders who work within the Directors
organization and have a vested interest in its Employees
success.
Connected These are stakeholders who have a Shareholders
relationship with the organization, often Creditors
through financial, contractual, or Suppliers
transactional links. Customers

External These are stakeholders who do not work Government

within the organization but are affected by its Local Community
operations or influence its business
environment.

Mendelow's Power-Interest Matrix

Mendelow’s Power-Interest Matrix is a strategic tool used to analyze and manage
stakeholders based on their power (ability to influence the organization) and interest (level of
concern about the organization’s actions). This helps businesses prioritize stakeholders and
decide the best engagement strategies.
Agency Theory
Agency theory examines the relationship between two parties — the principal and the agent
— where the agent is expected to act on behalf of the principal. However, conflicts can arise
when the agent’s interests differ from the principal’s goals. This theory is crucial in business
management, especially in companies with multiple stakeholders.

Shareholders (Principal) and Directors (Agent)

Principal: Shareholders own the company and expect directors to maximize profits.
Agent: Directors manage the company on behalf of shareholders. Their responsibility
is to generate maximum returns for shareholders.
Conflict: Directors might pursue personal interests (such as increasing their own
salaries) rather than maximizing shareholder profits.

Directors (Principal) and Employees (Agent)

Principal: Directors expect employees to work efficiently and productively.
Agent: Employees are responsible for carrying out tasks to achieve company
objectives.
Conflict: Employees may not always work to maximum efficiency if they lack incentives
or motivation.

Shareholders (Principal) and Loan Creditors (Agent)

Principal: Shareholders want the company to take loans at minimal risk to avoid
financial distress.
Agent: Loan creditors provide funds and expect repayment with interest.
Conflict: Shareholders might pressure the company to invest in high-risk projects that
could increase profits, while creditors prefer low-risk investments to protect
their loans.

Agency Issue between Directors & Shareholders

In large companies, shareholders own the business, but directors manage it on their behalf.
This is known as the separation of ownership and control. Directors are expected to act in the
best interests of shareholders, but conflicts can arise—this is known as the agency problem.

Agency Issue
Directors may have their own personal objectives that do not align with shareholder
interests, such as:
Increasing their own salaries and bonuses.
Expanding the company for personal status (“empire building”).
Securing their job positions rather than focusing on business efficiency.

Some directors may even act unethically to protect their own interests:
Creative Manipulating financial reports to make results look better than they are.
accounting
Hiding Using complex financial structures (e.g., special purpose vehicles) to conceal
corporate risks.
activity
Hiding Using complex financial structures (e.g., special purpose vehicles) to conceal
corporate risks.
activity
Blocking Preventing mergers to keep their jobs, even if a takeover benefits
takeovers shareholders.
Ignoring Prioritizing profits over sustainability (e.g., pollution, unethical testing).
environmental
concerns

Agency Costs
When directors pursue their own interests instead of shareholders', it leads to agency costs -
the loss of potential returns for shareholders due to inefficient management.
Agency Costs Maximum potential return - Actual return to shareholders

Solution: Corporate Governance

Corporate governance systems (like the Sarbanes-Oxley Act) help control director behaviour.
However, enforcing corporate governance also has costs, such as regulatory compliance
expenses. A cost-benefit approach is needed to ensure directors are monitored effectively
without excessive restrictions.

Example on Empire Building

Vijay Mallya, the chairman of United Breweries (UB) Group,
expanded his business empire beyond liquor and entered the
aviation sector by launching Kingfisher Airlines in 2005.

UB Group was highly successful in the liquor industry, but

Mallya aggressively expanded into aviation, an entirely
different industry.
Kingfisher Airlines started with luxury services that were unsustainable in a price-sensitive
Indian market.
To expand quickly, Mallya acquired Air Deccan, a budget airline, hoping to dominate both
premium and low-cost aviation. However, this merger led to financial instability.

Kingfisher Airlines accumulated massive debt, and by 2012, it had defaulted on loans of over
₹9,000 crore. Eventually, the airline shut down, and Vijay Mallya fled India.

Goal Congruence
Goal congruence occurs when the interests of stakeholders—such as shareholders, directors,
employees, and society—are aligned with the best interests of the company. This ensures
long-term growth rather than just short-term profits.
Methods to encourage Goal Congruence:
Employee Directors and key employees receive stock options, meaning they benefit if
Stock Option the company’s stock price increases.
Plans (ESOPs)

Long-term Directors are given bonuses based on multi-year performance rather than
Incentive Plans short-term earnings.
Transparency Companies must provide clear and accurate financial reports.
in Corporate Example:
Reporting
Tata Group’s strong corporate governance practices ensure investors trust
their financial statements.
Improved Independent directors (who are not part of management) oversee decisions
Corporate to prevent self-interest.
Governance
Shareholder Investors use their voting rights to influence company decisions.
Activism Example:
Institutional investors (E.g. LIC or SBI Mutual Fund) can demand changes in a
company if they feel the management is not acting in shareholders' best
interests.

Corporate Governance and Stakeholders

Traditionally, companies focused primarily on maximizing shareholder returns. However,
modern corporate governance emphasizes balancing the interests of all stakeholders—
creditors, employees, customers, and society—alongside shareholders.
This shift aligns with Corporate Social Responsibility (CSR) and Environmental, Social, and
Governance (ESG) principles, which encourage businesses to act ethically while maintaining
profitability.
Many companies now focus on “satisficing”—delivering acceptable profits while considering
ethical and environmental responsibilities. Shareholders increasingly favour companies that
follow ESG standards, even if it means slightly lower short-term returns.

How Investment and Business Strategies impact Stakeholders:

Stronger ESG Practices Lead to Companies that prioritize sustainability tend to outperform
Long-Term Gains competitors in crises.
Supporting Employees Treating employees well improves retention and performance.
Enhances Business Resilience Example:
Google offers higher salaries and benefits, leading to lower
employee turnover and higher productivity.
Government Compliance Companies that align with regulations avoid legal penalties.
Reduces Regulatory Risks Example:
Apple uses 100% renewable energy for its data centres,
reducing environmental scrutiny.
Collaborating with Businesses that work closely with suppliers and communities
Stakeholders Increases achieve better outcomes.
Efficiency
Example:
McDonald’s transitioned to sustainable packaging, cutting
costs and improving its environmental reputation.
Opening Share Price 10.00 $
Closing Share Price 12.90 $

$
Capital Gain i.e. growth in share price 2.90
Dividend 1.20
TSR 4.10

TSR (%) 41%

It comprises of two elements:

Capital Gain Yield 29%
Dividend Yield 12%
 No of Shares No of Year wx
(x) Outstanding
(w)
Opening Shares 400,000 1.0 400,000
Issued Shares 60,000 0.5 30,000
Total 430,000
Profit After Tax (PAT) 57,000 $

EPS PAT / Weighted No of Shares

EPS for the year ended 31st Mar, 20X6 0.133 $
EPS for the year ended 31st Mar, 20X5 0.103 $
Growth in EPS 28.70%

Self Note: Calculation of Growth

Growth 0.030 $
Growth 28.70%
(0.13 - 0.103) / 0.103
(0.13 / 0.103) - (0.103 / 0.103)
(0.13 / 0.103) - 1
Return on Capital Employed
LBC Industry
Surplus 20,000
Capital Employed 2,210,000
ROCE 0.90% 10%

Net Margin
LBC Industry
Surplus 20,000
Fares 1,200,000
Net Margin 1.67% 30%

Asset Turnover
LBC Industry
Fares 1,200,000
Capital Employed 2,210,000
Asset Turnover 0.54 0.33

Average Cost per Passenger Mile

LBC Industry
Operating Cost 1,180,000
Passenger Miles 4,320,000
Cost per Passenger Mile 0.27 0.37

Average Fare per Passenger Mile

LBC Industry Self Note:
Fares 1,200,000 Fare
Passenger Miles 4,320,000 Operating Cost
Fare per Passenger Mile 0.28 0.53 Net Margin

If Operating Cost is
Fare
100
70
30

0.37
0.53
A. FALSE
This is a classic example of the agency problem, where managers prioritize
their personal interests over shareholders' wealth. They may invest in
projects that benefit them personally but do not maximize company value.

B. FALSE
Managers may choose projects with quick payback periods to show short-
term success, even if long-term value is sacrificed. This misalignment of
incentives is a symptom of the agency problem.

C. FALSE

Empire building refers to managers expanding the business beyond optimal

levels to increase their own power, control, and prestige. This can lead to
inefficient use of resources, making it another consequence of the agency
problem.

D. TRUE
Financial gearing (leverage) involves increasing debt, which can be a strategic
decision aligned with shareholders' interests, rather than a result of
managerial self-interest.
(1) DECREASE
The average cost of capital (WACC) represents the minimum return a company must
generate to satisfy its investors (equity holders and debt holders).
It is used as a discounting rate. Therefore, increase in WACC reduces the present value of the
future cash flows of the company.

(2) DECREASE
The operating cycle is the time it takes for a company to convert inventory into cash.
An increase in the operating cycle reduces liquidity, which increases interest cost on
overdraft used to finance the working capital.

(3) DECREASE
A negative NPV project means that the project’s returns are less than the cost of capital and
will destroy value.

(4) INCREASE
Compliance with the corporate governance code enhances transparency, accountability, and
ethical business practices.
A. FALSE
It is consistent with "Economy" concept.

B. TRUE
It is not associated with any of the 3Es of the VFM Framework.

C. FALSE
It is consistent with "Efficiency" concept.

D. FALSE
It is consistent with "Effectiveness" concept.
(1)
Share price on 31st May, 20X5 8.35 $
Share price on 31st May, 20X4 7.40 $
Capital Gain 12.8%

(2)
Share price on 31st May, 20X5 8.35 $
Share price on 31st May, 20X6 6.48 $

$
Capital Gain i.e. growth in share price -1.87
Dividend 0.40
TSR -1.47

TSR (%) -17.6%

(3)
Earnings Yield EPS / Closing Share Price
20X6 20X5 20X4
EPS 0.589 0.642 0.607 Since the opening share price of 20X4 was not available,
therefore Earnings Yield was calculated using closing
Closing Share Price 6.48 8.35 7.40 share price.
Earnings Yield 9.1% 7.7% 8.2%
Avg Earnings Yield 8.3%

(4)
A. TRUE

B. FALSE
Dividend Cover PAT / Dividend It means how sufficient the profits are to cover dividend payout.
Dividend Payout Ratio Dividend / PAT It reflects the % of profit distributed as dividend.

C. TRUE

D. FALSE
Accounting Profit does not take account of risk.

(5)
A. TRUE
ROCE PBIT / CE
CE Equity + Debt
Preference Shares are also classified as Debt.
Preference Shares + Debt is known as Prior Charge Capital.

B. TRUE
ROE PAT / Equity
or
Net Margin x Net Asset Turnover
C. TRUE
Dividend Yield DPS / Share Price

D. FALSE
ROE PAT / Shareholders' Fund
 price of 20X4 was not available,
was calculated using closing

over dividend payout.